How to Multiply Investments in African Startups

Hello and welcome to FYI.

This week we present an answer to the central theme of the Global Entrepreneurship Week (GEW) of November 2014.

The GEW meetups were organized as part of VC4Africa’s celebration of African entrepreneurship. Hailed as Africa’s largest start-up event, the networking meetings were held in 40 cities across the world; from Abidjan, Dar es Salaam and Nairobi, to Helsinki, Nuremberg, and Seattle. In Abuja, the conversation focused on the importance of collaboration, the pursuit of early traction, and the encouragement of sustainable networks of entrepreneurs and investors.

Collaboration remains one of the most important buzzwords of the 21st Century. Across fields as diverse as construction, conflict resolution, and international aid, it’s changing how we find solutions to emerging problems. It is no surprise then, that African entrepreneurs are finding theirs through easily identifiable clusters that allow the early exchange of knowledge, skills, and ideas. The rapid growth of incubation centers and shared working spaces across the continent, and the fact that our meetup held in one, can only continue to encourage investments.

Traction is gained through early testing of a minimum viable product or service. Simply put, it presents a picture of what or who your customer is, how many potential ones currently exist, what they think of your product, and whether or not they’re willing to pay for it. Its role as proof of product acceptance and viability in the decisions of equity investors has been critical to the success or failure of many an African start-up to secure investments. The pursuit of early traction can therefore only encourage greater investments.

The role of networks of entrepreneurs and investors in driving investments in African start-ups cannot be over-emphasized. If the success of VC4Africa is anything to go by, an important space exists. However, we believe these spaces can be more effectively filled through sustainable, local networks. Talk of a proposed Abuja Angel Investor Network (to be unveiled this year) generated excitement among the entrepreneurs. Investisseurs & Partenaires (I&P) is already providing these options in Niger and Burkina Faso and has challenged investment teams across Africa to join their expansion project.

Finally, the importance of the knowledge of funding options to African entrepreneurs cannot be neglected. 21st-century business owners, regardless of company size or demography, face a constant battle to find the right balance between debt and equity. And if African start-ups want to attract and retain the right kind of investments, this knowledge can only be beneficial.

Your thoughts?

Editor’s Note: A version of this article first appeared in the Business Hub on 14th January 2015.

Business Funding Options: Equity Financing

Hello and welcome to FYI.

This week, we bring you the fourth installment of a five-part series on business finance. It’s about equity financing as an external source of funding and continues from previous posts on bootstrapping and debt finance.

So what is equity financing?

Simply put, equity is a stake in a business; a claim to both profits and losses. Equity financing therefore translates to raising money by trading a slice of the business in exchange for financial investment. These investors agree to a permanent partnership that can only be liquidated by the sale of their stake to the original owners or other new investors. As such, equity funds are not repayable and do not attract interest payments.

What are the sources of equity financing?

During the start-up process, family and friends in some instances would want a share of ownership as opposed to granting a loan. The fund received under these terms is classified as equity finance because they inevitably become shareholders in the business. It is important to note though, that once again the absence of drawn agreements and shareholding structure has led to lots of problems with equity investments from family, especially during future refinancing stages of the business.

The second source of equity financing is Angel Investors. These are usually business-savvy, wealthy individuals who bring networking opportunities in addition to interest-free leverage in exchange for a part of the business. They are the most sought-after type of investors and can come in during the early stages of the business life cycle. They not only share risk but also increase the probability of success through their personal experiences and relationships. They are however difficult to find and demand considerably higher stakes than family and friends.

A third source of equity financing is Venture Capitalists. These are the big-money investors that fund high-growth businesses in a bid to sell off or go public. They also bring networking opportunities, interest-free leverage, and a wealth of industry knowledge in exchange for a part of the business. They base their decisions on the competitiveness of the management team and sometimes insist on installing theirs. They also usually require an exit strategy that is achievable in not more than 5 years.

Another source of equity finance is Government Grants. These are highly competitive funds that are sponsored by Federal or State Governments in exchange for small stakes in the business. They usually carry single obligor limits and are directed towards growing small and medium enterprises in strategic sectors of the economy. A typical example of an equity grant is the type available to entrepreneurs under the YOUWIN program in Nigeria.

For businesses that become highly successful brands with established profitability, stable management, and growing public demand for goods and services, Initial Public Offerings (IPOs) provide further equity financing opportunities. These are however guided by Government regulations and are in most cases very expensive. It is also an important part of the exit strategy for other private equity financiers such as Venture Capitalists and Angel Investors.

And how do you decide on equity financing or the source to pick?

Any decision on equity finance must be based on the understanding that while traded equity provides leverage that doesn’t carry the weight of interests nor needs to be repaid, it slows down the decision-making process, and reduces your control of the business and share of profits in the long run. It is for this reason that equity finance is considered by some to be more expensive than debt in the long run. However, entrepreneurs in fast-growth industries, where economies of scale are crucial, understand that total ownership of a small business will not compare to a smaller slice of a larger one. For example, a 100% stake of N1million compared to a 25% stake of N100million.

For investors, the high risk of incurring losses means investments will only be tempting if the possibility of high returns exists. Businesses seeking equity finance must therefore prepare comprehensive business plans that show rapid profitability and feasible exit strategies. These strategies can range from buyouts from existing shareholders of the company to mergers and acquisitions that target other businesses, IPOs that target the general public, and even liquidation. Venture capitalists and Angel Investors particularly pay close attention to this aspect of the business.

If you haven’t considered these exit scenarios and the other funding options discussed are not favorable for your business, we still have one last part of the series to go. So just follow our social media page(s) and get notified.

In what other ways have you used equity to finance your business so far?

Editor’s Note: A version of this article first appeared in The Business Hub on 13th August 2014.

Business Funding Options

Hello and welcome to FYI.

This week, we look at funding options available to businesses. It’s the first installment of a five-part series focusing on business finance.

While business finance has always been a tricky affair, the list of options is growing. These options depend on the nature of your business, its current stage in the growth process, the availability of collateral, and the willingness to relinquish some control or share of the business. They can be classified into internal and external options.

Internal options include bootstrapping during the start-up process, and reinvestment of profits during the latter stages. Although external options were traditionally classified into two broad areas (debt and equity finance), innovations are bringing customers into the funding process earlier than ever before.

Bootstrapping is the process of using personal savings to run a business. In some cases, it is extended to include funds from loans against personal assets. While being the fastest and easiest way to start a business, it eliminates leverage or the ability to share business risk.

Debt financing can be accessible at different stages of the business life cycle. However, the source of funding depends on the availability of collateral and the current stage of the business. For small businesses in the start-up phase, the major external source of finance is family and friends. While being a one-time source, it is the cheapest form of leverage and requires no collateral and minimum agreements if any. And because of the personal relationship with the funding source, the appraisal is not always based on a convincing business plan or market realities. Rather, it is an investment in the business owner.

The second source of debt financing is Financial Institutions. This is considered expensive due to the requirement for payment of interest. It is difficult to access, slow, and cumbersome during the start-up phase but gets progressively easier as the business grows. Minimum requirements generally include a defined repayment plan, justified cash flow projections or business history, alternative sources of repayment through the provision of collateral, and reasonable asset liquidity. It is however an inexhaustible financing source as long as these basic requirements are met at every stage of the business life cycle.

Equity Financing is a rapidly growing source of funding for owners who are willing to give up ownership of part of the business. These sources also depend on the stage of the business. During the start-up process, family and friends in some instances would want a share of the ownership as opposed to granting a loan. The fund received under these terms is classified as equity finance because they inevitably become shareholders in the business. While providing leverage without the weight of interests, traded equity may sometimes reduce control of the business and slow down the decision-making process.

The second source of equity financing is Angel Investors. These are usually business-savvy, wealthy individuals who bring networking opportunities in addition to interest-free leverage in exchange for a part of the business. They are the most sought-after type of investor and can come in at different stages of the business life cycle. They not only share business risks but also increase the probability of success through their personal experiences and relationships. They are however some of the most difficult types of investors to find and demand considerably higher stakes in the business than family and friends.

A third source of equity financing is Venture Capitalists. These are the big-money investors that fund extremely rapid growth businesses in a bid to sell off or go public. They also bring networking opportunities, interest-free leverage, and a wealth of industry knowledge in exchange for a part of the business. They however rarely invest during the start-up stage, base their decisions on the competitiveness of the management team, and sometimes insist on installing theirs. They also usually require that the business be sold within five years or less.

This brings us to the latest trend in external business financing. The Customer. It is growing thanks to innovations in marketing and an all-time high in competition. Ever heard of Crowdfunding? It’s a process of raising funds through customers during the start-up phase. This can be as a pre-sale on a defined item or a promise of a discount on an innovative product. It is usually a cheap source of non-equity-based leverage; sort of like family and friends. While platforms like Kickstarter are leading the online revolution, innovations in real estate finance have promoted a rapid shift in the industry offline.

The second source of customer financing is Strategic Investors. These are businesses that combine elements of classic equity financing models to provide interest-free leverage in exchange for part of a business they buy from. They are usually driven by a potential for lower long-term costs, and the need to enjoy significant advantages over competitors. They could however end the relationship at any point in time while usually also restricting your ability to sell to their competitors.

It’s a lot of words, but we’re just getting started. Over the next four posts, we’ll help make sense of it all by matching business types to funding options. Follow our social media page(s) and get notified of the next installments.

For now, how have you funded different stages of your business so far? And what other funding options did we miss?

Editor’s Note: This post first appeared on The Business Hub on 23rd July 2014.